Weird Bonuses and Sales Reviews
Deutsche Bank AG might need to raise capital. One thing that makes it hard for banks to raise capital is that banks know what is in them and no one else does. There is a market for lemons problem. Banks are opaque and complicated, and if there is one thing the last few years have taught us, it is that there is always some new scandal lurking. The banks know what they own and what they're up to, and what scandals are lurking, but the investors who might buy their equity don't, or at least, they don't trust that they know everything they need to. And banks tend to raise capital when their risks and scandals are most off-putting. "Here, have some of this bucket of writhing goop," the banks offer, and the investors turn up their noses.
On the other hand, if you are already immersed in the goop, maybe you'll think that it's not that bad? That's the main logic behind stuff like this:
Deutsche Bank AG, Europe’s biggest investment bank, is exploring alternatives to paying bonuses in cash as Chief Executive Officer John Cryan seeks to boost capital buffers and shore up investor confidence, according to people familiar with the matter.
Executives at the German lender have informally discussed options including giving some bankers shares in the non-core unit instead of cash bonuses, said the people, who asked not to be identified because the deliberations are private. Another idea under review is replacing the cash component with more Deutsche Bank stock, they said.
This trade is essentially a price arbitrage. If you sell Deutsche Bank stock to outsiders who don't know or trust the bank, they won't pay you that much for it. But if you give it to insiders instead of cash for their bonuses, those insiders know and trust the bank -- because they work there and have had a hand in making the goop -- or at least they have to act like they do anyway. So you can get more bang for your buck by paying employees in shares than you can by selling shares to the public and using the proceeds to pay employees in cash. And this is especially true of the goopiest of the goop: Shareholders might dramatically discount the price of non-core operations, and raising capital by selling non-core equity directly to investors is particularly unappealing, but the bankers who understand the weird non-core stuff might be thrilled to own it.
There is a counter-argument that Deutsche Bank employees should value the goop less than the market does, because after all they are already swimming in it, and they can't diversify away their exposure to Deutsche Bank the way a regular investor could. These plans could "make retaining top staff more of a challenge," says Bloomberg Intelligence analyst Arjun Bowry. But this idea has worked great for Credit Suisse in the past, where bonuses paid in "toxic securities" that no one else wanted gave employees huge returns. Generally, the arbitrage should work if the bank is (1) embattled and (2) fundamentally sound, that is, if there's a big enough disconnect between how the public values the bank's weird stuff and how the employees do. Making employees eat the bank's cooking is fine, if they find it delicious. If they think it's poison, and have to eat it, they should quit. But if they think that then they shouldn't really be selling shares to the public either.
Meanwhile in retail banking.
In some ways the Wells Fargo & Co. fake accounts scandal was too easy: Wells Fargo bankers opened millions of accounts for customers without telling the customers, and that is just straightforwardly bad, so Wells Fargo is in trouble. But in the aftermath of that trouble, it seems increasingly like the big problem at Wells Fargo was not so much the fake accounts -- which mostly didn't charge fees and which many customers didn't notice -- but the real accounts that Wells Fargo opened for customers who didn't understand what they were getting. The outrage at Wells quickly moved on from "opening fake accounts" to "aggressive sales tactics," with those tactics driven by strict sales goals that forced bankers to constantly push products on customers. But a whole lot of aggressive sales tactics are distasteful, and even harmful, but not illegal. Opening three checking accounts for an unsophisticated customer without telling him is illegal. Opening three checking accounts for an unsophisticated customer because you have convinced him that he needs "separate accounts for such purposes as traveling, grocery shopping and saving for an emergency" is pretty much just as bad, but legally much grayer.
To ensure Wells Fargo & Co.’s scandal over unauthorized customer accounts isn’t being repeated at other lenders, regulators are poised to start reviewing data and talking to employees inside the biggest U.S. banks, according to a person familiar with the matter.
Wells Fargo’s largest competitors have received regulators’ formal requests for information and have been preparing for their practices to be scrutinized by examiners in the coming days, said the person, who requested anonymity because the process isn’t public.
But what do you scrutinize? If the test is, do other banks let their employees create millions of fake accounts associated with e-mail addresses like "firstname.lastname@example.org" (or "email@example.com," etc.), then it seems like a pretty easy test. If the test is, do banks only sell products to customers that the customers understand and that the banks think are in the customers' best interests, then that would be a pretty radical regulatory change.
Is banking fun?
“I know a client who went on a cruise and told the bank he was traveling,” says Andy Pringle at London recruitment firm Circle Square. “The problem for senior bankers is that it’s difficult to quantify what’s work and what’s not,” he adds. ” Often, your clients will be your friends, so if you go shooting with them or have a meal with them, is that work or is it pleasure?”
HSBC seems to be asking just that question. Matthew Westerman, the former Goldman Sachs banker who took over as head of HSBC’s global banking division in May is reportedly compelling his bankers to use a system that tracks exactly how they use their time, exactly how many clients they visit, and exactly how many deals they bring in. Seemingly gone are the days when you could mooch into the office at 11am before leaving for a ‘client lunch’ and reappearing at 4pm for two hours. HSBC bankers are said to be unhappy as a result.
Meanwhile, Wells Fargo has eliminated strict numerical sales quotas for retail bankers because of, you know. The challenge for banks is that, if you want to build deep and meaningful relationships with clients, you have to give those relationships some room to breathe. Bankers can't be selling all the time; sometimes they have to just spend time with the clients, building human connections without the pressure of an immediate transactional quota. But if the bank is too tolerant, the bankers will just hang out with their buddies all the time on the bank's dime, and never bring in any revenue. One solution is to make banking an exciting and lucrative job with highly variable compensation, so that smart ambitious people will be bankers and use their aggressive best judgment about how to build relationships that will bring in lots of revenue. That approach maybe worked better in 2006 than in 2016. Another solution is, you know, time tracking and quotas.
Blockchain blockchain blockchain.
Overstock.com, Inc., is doing a rights offering on the blockchain:
“This is the culmination of over two years of true innovation and hard work,” said Overstock CEO Patrick M. Byrne. “Through this public issuance of blockchain-based securities the history of capital markets is entering a new era, the era of blockchain-based securities.”
Overstock has been blockchain-obsessed for a while, and has a trading-technology subsidiary called t0 (a lower-case t and a zero, it's confusing) that is providing the platform for this. The blockchain interest may be related to Overstock's famous battle against naked short selling: If all of your shares are tracked on an immutable public distributed ledger, then you can always be sure that no one is naked short any "phantom shares," and you will sleep better at night, if naked shorting is the sort of thing that keeps you awake. (It has that effect on some people.) For now, the offering seems to be just for fun -- it's for up to a million voting preferred shares, at a to-be-determined price, and is intended "primarily to enable t0 to demonstrate the operation of the t0 platform, while providing Overstock’s stockholders of record the opportunity to participate" -- but if it works, you can imagine Overstock one day removing itself entirely to the blockchain.
Here is some correspondence between Overstock and the Securities and Exchange Commission, which includes a series of diagrams about how the blockchain issuance and trading will work. It is not what you might call a pure blockchain trading system, in which every participant helps to maintain a decentralized ledger of ownership and transactions, and in which trades are confirmed by consensus of everyone on the system. Instead, there's a central party -- PRO Securities ATS, the alternative trading system where the shares will trade -- that will maintain its own proprietary central ledger of transactions. But after each transaction, it will take a snapshot of that ledger and do a teeny bitcoin transaction, using "the T0.com software to embed the snapshot anchor data within that transaction," to essentially save its own encrypted ledger to the bitcoin blockchain. (Overstock's transfer agent will then check that the ledger matches what's on the blockchain.) So there'll be a public, verifiable, immutable record of each Overstock blockchain-stock trade. But the trades themselves will happen in PRO Securities' matching engine and registry, not quite "on the blockchain."
Limits to merger arbitrage.
If the proposed merger between AT&T Inc. and Time Warner Inc. closes as planned, Time Warner shareholders will get cash and AT&T stock worth $107.50. Yesterday Time Warner closed at $87.16. That's ... less. There is some reasonably straightforward arithmetic that you can do to translate that $20ish price gap into a market-implied probability that the deal will close:
Wall Street is giving the deal just a 28% chance of closing at the stated terms as of Tuesday’s market close, according to Macro Risk Advisors.
So if you think there's a 35 percent chance of the deal closing at its stated terms, I guess you should buy Time Warner stock. But the people who are in that business are capacity constrained:
The average U.S. deal size hit an all-time high of $476 million last year, and there were a record 33 deals over $10 billion, according to Dealogic.
Over the same period, the total assets controlled by hedge funds dedicated to merger arbitrage have stayed roughly constant at around $23 billion, according to HFR, meaning their firepower hasn’t kept pace with the mergers- and-acquisitions boom.
And "the average $1 billion-plus deal that has been agreed upon but not yet closed has been pending 144 days, the most since 2002," so more money is stuck in pending mergers.
One fun puzzle here is: Does that 28 percent implied probability of the deal closing mean that "the market" thinks that there is a 28 percent probability of the deal closing? Or has the market's mechanism for expressing that probability broken down a bit, as merger arbitrageurs just don't have enough money to express their views about the probability of giant mergers closing? If deal activity has grown much faster than merger arbitrage funds, and if those funds are locked into deals for longer, then the "arbitrage" part of merger arbitrage breaks down: If you think there's a 35 percent chance of AT&T/Time Warner closing, but you think some other deal is even more mispriced, you might focus your firepower there. On the other hand, if there was really too little money invested in merger arbitrage, and if arbitrage opportunities were going begging, the strategy would be performing better ("Merger-arbitrage-focused hedge funds are up 2% this year, half the gain for hedge funds overall"), and more money would be coming into it. Maybe the reason there's so little arbitrage money is because the expected probabilities really are so low.
A thing that bond salespeople sometimes do is go to a potential buyer and say "hey I have a seller of these bonds at 80," and go to a potential seller and say "hey I have a buyer of these bonds at 60," and convince the buyer to buy at 81 and the seller to sell at 59, and collect an embarrassingly gigantic spread. And one of my favorite puzzles in finance is: Is that illegal, or what? On the one hand, bluffing and misdirecting to try to maximize your profit is an ancient and beloved part of trading. On the other hand, directly lying about this stuff does seem to meet the technical definition of fraud. Prosecutors and regulators frown on this sort of thing these days -- the leading case, whose result is still uncertain, is the prosecution of former Jefferies trader Jesse Litvak -- so it's probably not worth doing, if you are a bond trader.
On the other hand, if you are in the business of negotiating product placements for Britney Spears videos, maybe give it a go? That is not legal advice:
Britney's lawyer fired off a threatening letter to Adam Kluger, claiming he went behind Britney's back and negotiated with Bumble to fund her new music video.
According to the letter, obtained by TMZ, Kluger allegedly told Bumble he had authority to rep Britney for an $800,000 deal that would put the Bumble name all over her new vid. The lawyer says Bumble agreed and gave Kluger $200k up-front. Kluger then made a deal with Britney's label, RCA, to pay them $450,000 for the Bumble product placement promotion.
Britney's people say what Kluger did is fraudulent, because he never repped Britney. They also say his $350k fee -- more than 43% of the deal -- is ridiculous and way above what agents charge.
I don't know, it sounds like he lined up a big trade that both sides were happy with, and kept the spread for himself? "He says his company is a creative agency that puts people and companies together, which is exactly what he did here." He'd have been a good bond trader, in an earlier, more innocent time.
Insider trading cartoons.
Here is a story about a former Securities and Exchange Commission lawyer who makes YouTube cartoons about insider trading law. "Someone legally prohibited from trading is shown with a padlock over the head, while volatile inside information is depicted by an exploding mushroom cloud," that sort of thing. They are pretty funny. Elsewhere, U.S. Attorney Preet Bharara rang the closing bell at the New York Stock Exchange yesterday. As far as I know he didn't arrest anyone on his way out.
People are worried about unicorns.
It's okay, unicorns, you can come out of the Enchanted Forest now, the weather is great out here:
Investors have shown intense interest in new shares that have come to market in the past month, especially technology issues. The average first-day pop for the eight U.S.-listed tech initial public offerings since mid-September is 50%, according to Dealogic.
That has helped lift the average first-day gain for new tech issues in 2016 to 32%, higher than in any other year since 2000.
Supply is a factor: "As of Tuesday, 20 tech companies had gone public in 2016, compared with 36 on average at that point in each of the past five years," so the unicorns are still pretty wary about wandering outside. But as one venture capitalist says, "It’s motivational for companies when they feel like there’s a prize out there." You stack enough unicorn treats along the borders of the Enchanted Forest, and eventually they'll come out.
Oh and Kobe Bryant is a venture capitalist now:
Mr. Bryant had a 44.7% field-goal percentage—the number of shots taken that went in—during his career. Asked if he’d be comfortable with a 5% success rate that is more common among VCs, Mr. Bryant didn’t hesitate.
“I’m going to shoot higher than that,” Mr. Bryant said.
People are worried about bond market liquidity.
The CFA Institute surveyed its members about what they think about bond market liquidity, and I guess it is fair to say that they are worried? At least in the Americas and Europe, the Middle East and Africa, where they reported decreases in liquidity, decreases in the number of dealers making markets, increases in the time to execute orders and more unfilled orders. The Asia-Pacific region reported that liquidity is fine, so that's a bright spot.
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